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Novum Alpha - Weekend Edition 18-19 December 2021 (10-Minute Read)

In a session which saw some of the heaviest trading volume this year, the benchmark S&P 500 extended its weekly slide and with the holidays fast approaching and many traders taking time off, the last opportunity for sufficient liquidity to allow investors to trade in and out of large positions. 

A wonderful weekend for that last-minute Christmas shopping as stocks plummet to attractive valuations. 

In brief (TL:DR)

  • U.S. stocks continued to fall into Friday with the Dow Jones Industrial Average  (-1.48%), the S&P 500  (-1.03%) and the Nasdaq Composite  (-0.07%) all lower as the prospect of tightening monetary policy continues to buffet sentiment. 
  • Asian stocks fell Friday following and closed lower as investors continue to be concerned over the Chinese property sector, tightening monetary policy and omicron risks. 
  • Benchmark U.S. 10-year Treasury yields slipped to 1.407% (yields fall when bond prices rise) as investors digested tightening monetary policy.
  • The dollar climbed.
  • Oil fell with January 2022 contracts for WTI Crude Oil (Nymex) (-2.10%) at US$70.86 on the prospect of fresh movement restrictions as omicron case numbers soar. 
  • Gold held gains with February 2022 contracts for Gold (Comex) (+0.37%) at US$1,804.90. 
  • Bitcoin (-3.32%) fell into the weekend to US$46,394 as investors continue to rotate out of risk and volatility increases.  



In today's issue...

  1. How low can yields stay? 
  2. The Trend is Not Your Friend, It Never Was
  3. MicroStrategy & the Bank of Bitcoin 



Market Overview

Hello volatility my old friend,
I've come to trade with you again,
while investors were softly sleeping,
assuming that the Fed would be keeping,
as low as the setting sun, as markets run,
this is the time of tapering.
(Sung to the tune of "Sound of Silence" by Simon & Garfunkel (c) 1964)   
In a session which saw some of the heaviest trading volume this year, the benchmark S&P 500 extended its weekly slide and with the holidays fast approaching and many traders taking time off, the last opportunity for sufficient liquidity to allow investors to trade in and out of large positions. 
A big week for policymakers and markets in U.S. and Europe saw central banks pivoting (at varying speeds) toward tighter policy, with inflation a bigger concern than the growth of the omicron variant. 
In Asia, markets finished a mixed bag on Friday with Tokyo's Nikkei 225 (-1.79%) and Hong Kong's Hang Seng (-1.21%) down, while Sydney’s ASX 200 (+0.11%) and Seoul's Kospi Index (+0.38%) were up at the close. 


1. How low can yields stay?

  • Prospect that central banks may be forced to eventually cut interest rates again in anywhere between two to four years has been priced into markets 
  • Yet when the Fed delivered exactly what it promised, far from sending markets plummeting, stocks reversed course in a plot twist so unforeseen it could have been taken off the page of a daytime soap opera script.
“You turn if you want to, the Lady’s not for…oh what the heck, I’m turning too.”
In the wake of the U.S. Federal Reserve’s widely expected accelerated taper of asset purchases, all eyes were on the Bank of England as to what it would do next.
Last month, the Bank of England kept interest rates right where they were, even though language from the Chancellor of the Exchequer led most to price in a rate hike.
Markets responded well when the Bank of England chose to maintain rates last month, but peer pressure from the Fed has since seen the U.K.’s central bank lead the way with its surprise rate hike.
Investors are now having to gird themselves for a significant leap in global bond yields, with the Bank of England shocking markets this past week with its first rate hike since 2018.
The U.S. Federal Reserve has laid out a plan for raising rates in 2022, but the European Central Bank has reiterated that rates would remain low, even as it has raised inflation expectations.
With the latest policy meetings, the three major global central banks have staked their credibility on fighting inflation, with two of the three likely to tighten monetary conditions despite the prospect of fresh Covid-induced lockdowns.
But market participants seem to be betting that the Fed can’t keep up the low rate charade indefinitely, with some traders already pricing in a potential rate cut in two to three years – the market is not entirely confident the U.S. economy can handle any more Fed hawkishness.
To be sure, the Fed hasn’t increased the number of rate hikes in its so-called dot plot, it’s simply moved them forward.
But if defaults are not an option to de-lever the financial system, a period of negative real returns, thanks to rising inflation, will be the inevitable consequence, which suggests that the recent sharp pullback in risk assets and in particular tech stocks, may not have fully considered this possibility. 


2. The Trend is Not Your Friend, It Never Was

  • Investors are having to contend with elevated levels of volatility even as competing narratives fight for dominance 
  • Lack of conviction in either direction means that volatility is the only given for markets as central banks tighten and omicron poses fresh risks 
An oft heard adage among stock traders, “the trend is your friend until it ends,” seems somewhat flippant given current market circumstances.
Down one day, up the next and often times within the same day, investors are suffering whiplash from volatility that defies explanation by any one convincing narrative.
Nowhere is this more pronounced than in tech stocks represented by the Nasdaq 100, where the absolute size of close-to-close moves up or down has been three times as much as any December since 2018 and almost twice the average move from last year.
To be sure, there are plenty of forces at play – from the fast-spreading omicron variant at a time when the U.S. Federal Reserve has taken a hawkish the turn and the Bank of England has raised interest rates.
Some suggest that the latest tightening of monetary policy may mark an end to an easing cycle that has underpinned a 20-month, US$60 trillion rally in global equities, but this ignores strong earnings, guidance and operating results.
But the rising volatility does serve as a stark reminder that Fed action in the coming years could be more impactful than the almost two years of fearless trading in the riskiest of risk assets, on the assumption that liquidity would be plentiful.
Volatility is being exacerbated because it’s really anyone’s guess if the Fed can engineer a soft landing – taming inflation, without choking off growth.
Although markets initially shrugged off concerns over the Fed’s accelerated taper with robust comments on the economy, with U.S. Federal Reserve Chairman Jerome Powell characterizing income and demand as strong, these brave words were tempered by a drop in long-dated U.S. Treasury yields (yields fall when bond prices rise).
Big swings in either direction reflect an elevated level of confusion among market participants because so many conflicting narratives abound.
Some strategists such as Credit Suisse Group are suggesting that it’s safe to buy stocks at the early stages of a tightening cycle, while counterparts like Bank of America warn that this time could be different as inflation is out of control.
Unfortunately, either of them could be right, because these are unprecedented times and while markets are reacting despite the Fed simply accelerating the pace of the taper to allow for some monetary policy flexibility, it’s less clear what will happen next.
Markets abhor uncertainty as much as nature abhors a vacuum and with no conviction in either direction, it’s easy for investors to run like headless chickens both for the exits and for the opportunities.
But the excessive bearishness may set the stage for a rebound into the new year, when the pandemic (hopefully) comes to an end and the economy keeps expanding, which is why this could really be a short squeeze resulting in a cyclical rally into the year end and January.
At this stage though, anyone’s guess is good.

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3. MicroStrategy & the Bank of Bitcoin

  • MicroStrategy considers plan to lend out bitcoin to generate yield on its 122,000 or so bitcoin stash
  • Successful move to generate yield on bitcoin may be game-changing and tempt other companies to hop on the bitcoin bandwagon to bolster balance sheets 
These days the software firm known as MicroStrategy appears to be more of a cryptocurrency company than an enterprise solutions provider.
While MicroStrategy has a suite of enterprise software and analytics products, the company is better known for its vocal bitcoin-backing founder and CEO Michael Saylor (with the laser eyes no less) and its cryptocurrency-heavy balance sheet.
With no less than 122,000 bitcoin on its books (or ledger if you prefer), MicroStrategy first made waves by issuing debt to buy bitcoin and is now looking for ways to generate yield on its massive cryptocurrency holdings.
Last Thursday, Saylor discussed the strategy on an investor day call with shareholders,
MicroStrategy has been using cashflows from its main business to buy bitcoin, even as it issued two convertible bonds and a secured junk bond to raise money to acquire more bitcoin.
At current prices, MicroStrategy’s bitcoin haul is worth around US$5.6 billion (at time of writing, check back later).
Although Saylor said on the investor call that MicroStrategy hasn’t put in place any concret steps yet to deploy its bitcoin stash, he noted,
“There may be opportunities to either put a mortgage against it and generate long-term debt under favorable circumstances, which we could leverage up against the bitcoin, or we think that we could lend it to a trustworthy counterparty.”
To be sure, lending out cryptocurrency is not a new concept and is a thriving business and key component of the growing decentralized finance or DeFi industry, where token holders often stake their positions in exchange to provide liquidity, in exchange for attractive yields.
But if MicroStrategy were to lend out even a portion of its massive bitcoin war chest, estimated to constitute some 0.38% of global supply, it could potentially put downwards pressure on the elevated DeFi lending yields.
Significantly, if MicroStrategy could find the right fit, whether a big tech company or bank, Saylor suggests,
“That could become a good source of income for us (MicroStrategy), or we could develop it with some kind of interesting applications.”
And that could challenge some of the criticisms of bitcoin, for instance that it just “sits there” and that it generates no yield, akin to gold. 


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Dec 18, 2021

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